Vermilion Energy Inc

TSX:VET

Earnings Call Transcript 2022-Q1

[Kyle Preston, executive]

Good afternoon, ladies and gentlemen, and thank you standing by. Welcome to Vermilion Energy's Virtual 2022 Annual General Meeting. Following the formal portion of the meeting, a presentation will be given by Dion Hatcher, Vermilion's President.

As a reminder, this event is being broadcasted live on the Internet and is being recorded. The archived event will be posted on Vermilion's website under the heading, Invest with Us and subheading Events and Presentations.

[Operator Instructions] I would now like to turn the conference call over to Lorenzo Donadeo, Vermilion's Executive Chairman. Please go ahead, Mr. Donadeo.

[Lorenzo Donadeo, executive]

Thank you, operator. Good afternoon, ladies and gentlemen. As permitted by Vermilion's bylaw number one, our meeting will be held today as a virtual-only shareholder meeting with participation electronically, as explained in the proxy statement and information circular, which was mailed to all shareholders on April 8, excuse me, 2022.

By holding this virtual meeting, we are able to welcome a broader base of shareholders to participate regardless of geographic location. I would like to begin by welcoming you to Vermilion's Virtual 2022 Annual General Meeting of Shareholders. We will complete the formal part of this meeting first. And afterwards, Dion Hatcher, the President of the company, will provide you with an overview of our business and an update on our strategy moving forward.

Customers are not able to be together in person, I would like to review the rules for discussion and debate to facilitate an orderly virtual meeting. Formal meeting will deal with the items of business outlined in the proxy circular. Once we have completed that work, we will move to the informal part of the meeting.

During the formal meeting, each shareholder or proxy holder wishing to address a motion may do so when I have indicated the motion is open for a discussion. To participate in the discussion, select the messaging tab, take your comment and click the send button. Each shareholder may take up to 5 minutes to contribute to the discussion, but I reserve the right to terminate the discussion on a matter.

All discussion must be courteous and respectful of other participants in the meeting. All questions from management will be dealt with in the informal part of the meeting after the formal meeting is completed. Thank you in advance for your cooperation.

Ladies and gentlemen, the meeting will now come to order as Executive Chairman of the Board of Directors of Vermilion Energy Inc., it is my responsibility and privilege to chair this Annual General Meeting of the shareholders of Vermilion. Jamie Gagner of Lawson Lundell LLP, will act as Secretary of the meeting; and Jacquie Fisher of Odyssey Trust Company will act as a scrutineer.

I would like to welcome to the meeting all others participating in the online meeting. At this point, I would like to introduce the other directors of Vermilion electronically attending the meet today, Robert Mekaleski, James Kleckner Jr.; Carin Knickel; Stephen Larke; Timothy Marchant; William Roby; Manjit Sharma and Judy Steele.

Mr. McDonald has advised that he will not stand for reelection to Vermilion's Board in 2022. Mr. McDonald dedicated over 20 years of service to Vermilion. He has been instrumental in Vermilion's long-term success with a focus on long-term value creation and a strong commitment to providing a safe work environment for all Vermilion's employees and contractors.

Most recently in his role as Lead Director, Mr. McDonald provided independent thought and best practices to ensure decisions were made in consideration of the interest of all stakeholders. On behalf of the entire management and the Board of Directors of Vermilion, we would like to thank Mr. MacDonald for his significant contributions to Vermilion's success over the years, and we wish him the best in his future endeavors.

As we have previously announced, I will be retiring from the Board and my executive position, effective September 1, 2022. I cofounded Vermilion in 1994 and have been a dedicated member of the senior leadership and Board of Directors for the last 28 years.

Vermilion is once again financially and operationally strong with a diversified asset base, currently generating record levels of free cash flow that provides a basis for strong returns to our shareholders. I have worked closely with the new leadership team, and I have a high degree of confidence in their expertise and their alignment with Vermilion's business principles.

This high-performing leadership team, together with Vermilion's 2030 strategic plan will position the company well for continued strong long-term performance. It's been an incredible and enjoyable 28 years, which will provide me with many fond memories, but it is time for me to create some space and flexibility in my time for me and my family.

I would like to thank all of the employees, the Board, our advisers and all of our shareholders for their support over the years whom have contributed to Vermilion delivering superior rewards to all of its stakeholders. We appreciate your confidence in Vermilion, and I thank you for your support.

Excuse me, I would also like to introduce members of the executive leadership team participating electronically in the meeting. Dion Hatcher, President; Lars Glemser, Vice President and Chief Financial Officer; Bryce Kremnica, Vice President, North America; Darcy Kerwin, Vice President, International and Health and Safety and Environment; and Jenson Tan, Vice President, Business Development.

The notice calling this meeting of shareholders, the proxy for use at this meeting and the proxy statement and information circular were mailed on April 8, 2022, to all shareholders as of the record date for this meeting, being the close of business on March 22, 2022.

As part of our ongoing stewardship of the environment and as a cost-saving measure for the fourth consecutive year, beneficial shareholders received a voting instruction form and a notice and access notification, which included a link to the meeting materials consisting of the proxy statement and information circular and the 2021 annual report.

The procedure for the electronic delivery of median materials is known as notice and access, and as mentioned, is an environmentally friendly alternative that is now used by a number of companies. As in past years, registered shareholders and those beneficial shareholders that had previously requested to receive paper copies continue to receive a printed copy of the meeting materials in a form of proxy.

I would ask that copies of all such documents be filed with the minutes of this meeting. A quorum for the transaction of business at today's meeting is at least 2 people present, being registered shareholder or duly appointed proxy holder and representing an aggregate -- in aggregate, not less than 25% of the total outstanding common shares.

According to Vermilion's bylaw, a person participating in today's meeting through the virtual meeting platform for today's meeting is deemed to be present at the meeting. I am advised by the scrutineer that there is a quorum present. The scrutineer's report is available for inspection, and I ask the secretary to file it with the minutes of this meeting.

I, hereby, declare this Annual General Meeting of Shareholders of Vermilion Energy, Inc. to be properly convened and regularly constituted to conduct business. There are various matters of business to be dealt with today. A description of each matter is provided in the information circular, a copy of which is available on our website under the heading, Invest with us and sub-heading Annual General Meeting.

In the interest of time, I do not propose to make a detailed presentation of each item. For the purposes of moving the meeting along, shareholders who are representatives of Vermilion, Lars Glemser, Bryce Kremnica, Darcy Kerwin, and Jenson Tan have been asked to move and second the motions to be brought before the meeting.

I would like to take a moment to comment on the voting procedures to be used at today's meeting. Voting for all matters will proceed by way of electronic ballot through the virtual meeting platform. The polls are now open and will remain open until the end of the formal part of the meeting.

If you have not voted your shares, please vote now. If you wish to wait until the end of the formal session, there will be additional time allotted for voting as well. If you have previously voted, you do not need to vote again. By voting again, you will revoke your share -- your votes made prior to the voting cutoff.

And only the live votes will be counted. The ex -- pardon me, the exact results of the ballot voting on the items of business at today's meeting will be announced tomorrow, Thursday, May 12, in our press release and in the report of voting results and will be filed on sedar.com under Vermilion's profile.

First item of business is fixing the number of Directors of Vermilion Energy, Inc. to be elected at 9. May I have a motion to fix the number of directors to be elected at 9.

[Lars Glemser, executive]

My name is Lars Glemser, and I am a representative of Vermilion and a shareholder. I move that the number of directors of Vermilion Energy, Inc. to be elected be fixed at 9.

[Lorenzo Donadeo, executive]

May I have the motion seconded?

[Bryce Kremnica, executive]

My name is Bryce Kremnica, and I am a representative of Vermilion and a shareholder. I second the motion.

[Lorenzo Donadeo, executive]

I am advised that there is no further discussion requested on this item. The next item of business is the election of the directors of Vermilion for the ensuing year or until their successors are elected or appointed. As we have done in previous years, we will be nominating and approving individual directors and not a state of directors.

The Board of Directors has adopted a policy stipulating that if a director nominee receives a greater number of votes withheld from the election of that director and votes for the election, the nominee will offer to resign.

The Governance and Human Resources Committee will then review the matter and recommend to the Board whether to accept the resignation and the Board's decision to accept a rejective resignation will be publicly announced within 90 days of the meeting.

It is expected that resignations will be accepted, except in situations where exceptional circumstances, would warrant that the applicable director continue to serve as a Board member. Board of Directors to be elected at the meeting has been fixed at 9. Information with respect to each of the nominees as set forth in the information circular for this meeting.

I now declare the meeting open for nominations for the Board of Directors of Vermilion Energy, Inc. May I have a motion to nominate the Board of Directors of Vermilion Energy, Inc.

[Darcy Kerwin, executive]

My name is Darcy Kerwin, and I'm a representative of Vermilion and a shareholder. I nominate Lorenzo Donadeo; James Kleckner, Jr.; Carin Knickel, Stephen Larke; Timothy Marchant; Robert Michaleski, William Roby; Manjit Sharma and Judy Steele as Directors of Vermilion Energy, Inc. for the ensuing year.

[Lorenzo Donadeo, executive]

I will now ask to move the resolution electing those individuals nominated as Directors of Vermilion Energy, Inc. to serve as directors until the close of the next annual meeting of shareholders or until their successors are duly appointed.

[Jenson Tan, executive]

My name is Jenson Tan, and I am a representative of Vermilion and a shareholder. I move that each of the 9 persons nominated be elected as a Director of Vermilion Energy, Inc. to hold office until the close of the next Annual Meeting of Shareholders or until a successor is duly elected or appointed.

[Lorenzo Donadeo, executive]

May I have the motion seconded?

[Unknown Attendee]

I second the motion.

[Lorenzo Donadeo, executive]

As previously stated, the Directors will be individually -- will be elected individually and not by the State. For a nominee to be elected as a Director of Vermilion Energy, Inc. The votes cast in favor of the election of the director nominee should represent no less than a majority of the votes cast by shareholders represented in person or by proxy at this meeting.

Is there any discussion? I am advised that there is no further discussion requested on this item. The next item of business is the appointment of the auditors of Vermilion. Deloitte LLP are Vermilion's current auditors and have agreed to act as auditors of Vermilion, if appointed.

May I have a motion for the appointment of the auditors.

[Unknown Attendee]

I move that Deloitte LLP be appointed as the auditors of Vermilion to hold office until the next Annual General Meeting of Shareholders.

[Lorenzo Donadeo, executive]

May I have the motion seconded.

[Unknown Attendee]

I second the motion.

[Lorenzo Donadeo, executive]

Is there any discussion? I am advised that there is no further discussion requested on this item.

The next item of business is the advisory vote on executive compensation. As part of Vermilion's ongoing commitment to strong corporate governance practices, the Board has determined that it would be appropriate to hold a nonbinding advisory vote at this meeting on the approach to executive compensation, commonly referred to as a say-on-pay advisory vote.

This is the eighth year we are holding a say-on-pay advisory vote with an average 85% shareholder support over the last 8 years. Last year, we failed to say-on-pay vote, receiving a support of 42%. The vote on executive compensation was an advisory vote, and the results were not binding upon the board.

However, in response to the shareholder engagement, we have made numerous changes to our programs. A detailed discussion of our shareholder engagement and corresponding compensation program changes made are set out on Pages 17 to 20 of the information circular and the approach to executive compensation is set forth in the executive compensation section of the information circular.

2 leading independent third-party proxy advisory firms, [ ISS and Glass teas ] have both recommended that shareholders vote for all of the proposed resolutions, including the say-on-pay advisory vote. May I have a motion for the say-on-pay advisory vote.

[Unknown Attendee]

I move that on an advisory basis and not to diminish the role and responsibilities of the Board of Directors that the shareholders accept the approach to executive compensation disclosed in the information circular accompanying the notice of this meeting.

[Lorenzo Donadeo, executive]

May I have the motion seconded?

[Unknown Attendee]

I second the motion.

[Lorenzo Donadeo, executive]

Is there any discussion? I am advised that there is no further discussion requested on this item. The next item on the agenda is the approval of the Omnibus Incentive Plan. The principal purposes of the plan include providing a competitive long-term incentive program to attract, retain and strengthen the ability of Vermilion and its affiliates to retain qualified employees, officers, directors and consultants and promoting a proprietary interest in the company through share ownership in alignment with the interest of shareholders.

The Omnibus Incentive Plan governs the grant of share awards, deferred share units, bonus awards and employer share savings plan contributions. The number of common shares reserved for issuance by the company under the plan is based on a 3.5% treasury growing reserve.

In addition to common shares issued from treasury awards may be settled with cash or common shares acquired through exchange facilities. To be effective, the resolution approving the Omnibus Incentive Plan and all unallocated entitlements under the plan must be passed by a majority of votes cast by the shareholders present in-person or represented by proxy at the meeting.

[Unknown Attendee]

I move that the ordinary resolution to approve the Omnibus incentive plan and all unallocated entitlements under the plan, the full text of which is settled on Page 22 of the information circular accompanying the notice of this meeting, be approved and authorized and the approval be effective until May 11, 2025.

[Lorenzo Donadeo, executive]

May I have the motion seconded?

[Unknown Attendee]

I second the motion.

[Lorenzo Donadeo, executive]

Is there any discussion? I am advised that there is no further discussion requested on this item. If you have not already voted, please complete the electronic ballot for all items of business now through the virtual meeting platform. The voting will close momentarily.

The next item of business is to table the consolidated audited financial statements of Vermilion for the year ended December 31, 2021, and the report of the auditors thereon. These financial statements were included in Vermilion's annual report, which was mailed to those shareholders who requested the financial statements, along with the notice of this meeting and the information circular.

For your ease of reference, links to Vermilion's annual report, which includes the financial statements are available on our website under the heading, Invest with Us, subheading Reports and Filings. Are there any questions regarding the financial statements? I am advised that there is no questions regarding the financial statements.

At this time, the voting is closed on all items of business. Please allow us a few moments to tally the votes and collect the scrutineers report. As mentioned at the beginning of the meeting, the exact results of the ballot voting on the items of business at today's meeting will be disclosed on the voting results report and our press release, which will be filed tomorrow, Thursday, May 12, 2022.

The scrutineers have provided the preliminary report of the results of voting at today's voting. On the matter of fixing the number of Directors of Vermilion Energy, Inc. to be elected at 9. I am advised by the scrutineer that greater than a majority of the votes cast have been voted in favor of this resolution.

Therefore, I declare the motion to fix a number of directors is carried. On the matter of electing Directors of Vermilion Energy, Inc., I am advised by the scrutineer that for each of the director nominees, greater than the majority of the votes cast has been voted in favor of the election of each Director.

Therefore, I declare that this motion is carried and each of the nominees for election as director has been elected. On the matter of appointing Deloitte LLP auditors to hold office until the close of the next Annual Meeting of the shareholders or until their successors are appointed, I am advised by the scrutineer that greater than the majority of the votes cast have been voted in favor of the appointment of Deloitte as auditors. Therefore, I declare that this motion is carried.

On the matter of the approval of the 'Say on Pay' advisory vote, I am advised by the scrutineer that greater than a majority of the votes cast have been voted in favor of this resolution. Therefore, I declare that this motion is carried.

On the matter of the approval of the Omnibus Incentive Plan, I am advised by the scrutineer that greater than the majority of the votes cast have been voted in favor of this resolution. Therefore, I declare that this motion is carried.

Is there any further business? As there is no further business to be brought before this meeting, the meeting is concluded. I will now turn it over to Dion Hatcher, President of Vermilion to provide you with an update on our business and our strategy moving forward. Questions will be addressed at the end of this presentation.

[Anthony Hatcher, executive]

Thank you. Thank you, Lorenzo, and thank you to everyone that joined us today. Now I'm going to provide you an update and overview of our 2021 results, discuss our Q1 2022 results, provide a general update on how things are shaping up for the balance of the year.

Before I get started, I would like to refer to our advisory on forward-looking information. Describes forward-looking information, non-GAAP measures and oil and gas terms used today and outline the risk factors and assumptions relevant to this discussion.

Turn off on Slide 16. I want to remind you of the core business principles that we outlined in 2020, maintain a strong balance sheet with low financial leverage, managed total payout ratio of less than 100%, consistently deliver results that meet or exceed expectations, protect equity and minimize dilution, maintaining a strong corporate culture.

These principles are used to guide management's decisions as well as execute on our business. They have served us well over the past few years and will continue to guide us in the future. We appreciate the results we delivered in 2021.

I think it's important to remember where we started the year. Looking at the 2020 column in the table on Slide 18, you can see that we ended 2020 with an overloaded balance sheet, and our #1 financial priority was to reduce debt.

With this going focus, we announced a modest capital budget aimed at preserving liquidity, maximizing our free cash flow and reducing debt while positioning the company for long-term success. On the operational front, we delivered annual production of 85,400 BOEs a day, which was at the top end of our operatively revised guidance.

With the help of strong commodity pricing environment, we generated a record $920 million of fund flow and $545 million of free cash flow in 2021. As a result of this strong free cash generation, we're able to make significant progress on our debt reduction. We reduced our net debt by $365 million in 2021, and we exited the year with a net debt to trailing fun-fill ratio of 1.8x that is less than half of what it was at the start of the year.

In addition to accelerating our debt reduction in 2021, we announced over $700 million of strategic acquisitions including a bolt-on of a high-quality inventory consolidation deal in the U.S. and a high-return, low-risk acquisition to consolidate our operating natural gas assets in Ireland.

We did all this with a selling assets into a distressed market for issuing equity at depressed prices. This ensures we maximize per-share value for our long-term shareholders. As I mentioned, robust commodity prices contributed to our strong 2021 financial results.

Slide 19 provides more perspective on the historical and forward-looking prices of the forming commodity benchmarks that we have exposure to. As you can see, all of these benchmarks were up in 2021, and this trend has continued into 2022. Fundamental backdrop for energy commodities is strong, and Vermilion is very well positioned to capitalize on this strength owing to our international and diversified portfolio.

Not only the commodity prices strengthened in the first few months of 2022, but we have seen the forward curve strengthen relative to the beginning of the year, the biggest increase is in 2023 strip price is European gas, which is up approximately 100%. This bodes well for our 2023 cash flows as pro forma 22% of our production is European gas.

We announced our 2022 budget and guidance in November. In March, we upwardly revised it to a $500 million E&D capital budget with an annual production guidance of 86,000 to 88,000 BOEs a day. This revision includes the partial year impact of Leucrotta acquisition, but does not reflect the Corrib acquisition, which is on track to close in the second half of 2022, including the impact from Leucrotta and Corrib acquisitions, we expect to exit 2022 with production of 95,000 to 100,000 BOEs a day, which we intend to maintain for the foreseeable future.

We announced on Q1 -- we announced our Q1 2022 results just a couple of hours ago. As shown on Slide -- sorry, as shown on Slide 22, we are off to a very strong start. We delivered another quarter record fund flows and record free cash flow, and we continue to make significant progress on our debt reduction targets.

We delivered average production of 86,200 BOEs a day, which represents a 2% increase over the prior quarter. We have now met or exceeded market expectations for 8 consecutive quarters, which is a reflection of our strong execution and shift to a more low-leveled and optimized capital program.

Strong commodity prices during the quarter, including premium European gas, resulted in record quarterly fund flows of $390 million, representing a 21% increase over the prior quarter. E&D capital expenditures were $85 million resulted in record quarterly free cash flow of $305 million.

The vast majority of this free cash flow was allocated to debt reduction, while the remainder was used to fund acquisitions, asset retirement obligations and our recently reinstated quarterly dividend. We reduced net debt by $280 million from year-end 2021 to $1.365 billion at the end of Q1, reflecting a net debt to trading fund flow ratio of approximately 1.2x.

This represents a significant improvement over the previous quarter of 1.8x in the prior year of 3.9x. We are now within our long-range target of 0.8x to 1.2x. We continue to make progress on the Corrib acquisition and expected to close in the second half of the year.

As a reminder, the economic benefits of this acquisition accrued to Vermilion as of Jan 1, 2022, including the incremental 36.5% in Corrib, our pro forma Q1 fund flow and free cash flow were $575 million and $489 million, respectively. The pro forma Q1 results highlights our robust free cash flow generation of almost $0.5 billion in 3 months.

At the end of the quarter, we announced the strategic acquisition of Leucrotta Exploration, a transaction that will enhance our North American portfolio by adding fully delineated multi-decade free cash flow-generating Montney asset. This acquisition, combined with our previously announced Corrib acquisition will be fully funded within the 2022 free cash flow and further underpins our longer-term return of capital strategy.

The Corrib and Leucrotta acquisitions are very strategic transactions they align very well with our value-driven acquisition strategy. As outlined on Slide 23, we target underexploited consolidation opportunities in core areas with upsized development potential that generate strong free cash flow.

In Europe, we typically acquire from the majors, and we're able to execute these very high return opportunities. We have a strategic advantage given our 25-year operating history, which brings a deep understanding of the regulatory environment and strong relationships with key stakeholders.

Although international deal flow has historically been limited, it is now increasing as the majors announce plans to divest. We will continue to be patient and opportunistic as we evaluate new opportunities. Our acquisition approach in North America is different. We have a track record of developing multi-zone horizons that have infrastructure synergies.

We have built positions in our core operating areas of West Central Alberta, Southeast Saskatchewan and Wyoming, and we have recently expanded into the Montney. We are not looking to do any significant transactions in North America at this time, but we will continue to evaluate small tuck-in acquisitions to further strengthen these core areas.

Slide 24 provides an overview of the Corrib acquisition announced in November 2021. This transaction increases our exposure to premium European gas and add significant near- to medium-term free cash flow generation, which will enable us to accelerate debt reduction and return our capital to shareholders.

Given strong euro gas prices and the deal contingent hedges implemented with this transaction, we expect to achieve pay in less than 2 years, we will then be in a position to harvest this free cash flow from the asset for over the next decade plus.

Moving on to the Leucrotta transaction on Slide 25. This acquisition enhances our North America depth and quality of inventory by adding multiple decades of high-value Tier 1 Montney drilling locations. This development plan is self-funded and once we reach plateau rates of approximately 28,000 views a day in the next few years, we expect this asset to contribute over $200 million of annual free cash flow, which will again enhance our long-term return of capital.

As I mentioned earlier, we were able to fund both of these transactions with internally generated free cash flow in 2022. This is a very accretive to our shareholders as it adds 16% production per share growth. So as you can see, these 2 acquisitions are very complementary to Vermilion's portfolio of enhanced long-term shareholder value.

Pulling it all together, what does Vermilion look like on a go-forward basis? Slide 27 provides a summary of our 2022 based on the current forward strip prices. As shown in the table, we forecast pro forma annual fund flows of $2.8 billion before hedging or $2.2 billion net of hedging.

After deducting our $500 million of E&D capital, we forecast free cash flow of $2.3 billion before hedging or $1.7 billion net of hedging. That is over $10 per share of free cash flow after hedging. With this free cash flow, we're able to fund $1.1 billion of acquisitions, increase our production per share of 16%, reinstate base dividends and we're forecasting to achieve our year-end net debt target of $1.2 billion.

We have not provided formal guidance for 2023 other than indicating our intention is to maintain production at our 2022 exit rate of 95,000 to 100,000 BOEs a day and assumed capital expenditures of $500 million to $550 million. We expect strong free cash flow again in 2023 and with only 10% of our 23 production hedged, we have good exposure to even higher prices in 2023.

As you can see, Vermilion is in a very strong financial position, and we look forward to pulling forward to outlining our return of capital framework as we approach our $1.2 billion target in the second half of 2022. The next section, I'm going to speak about the Vermilion advantage and what differentiates our business from many of our peers.

As shown on Slide 29, we are an internationally diversified energy company with assets in North America, Europe and Australia. Our international assets generate 58% of our fund flow and 62% of our free cash flow. Slide 30 outlines some of the advantages of our international diversified portfolio.

We have exposure to premium-priced global commodities. Many of our assets are conventional or semi-conventional reservoirs, which means we typically have lower base decline rates compared to our peers. This diversification helps mitigate risk, provides access to high-return acquisition opportunities as demonstrated with the recent Corrib acquisition, and it provides more opportunities for capital allocation.

Another key advantage that is often overlooked is how we leverage operational and technical learnings across our business units to optimize the overall effectiveness of the business. We often take North America technology and apply it to these international assets, which can add significant value through enhanced resource recovery or more efficient operations.

Having exposure to global commodity prices is one of the key advantages of our international diversified portfolio. Looking first at oil on Slide 31, you can see the advantage we have from having Brent price oil in our portfolio, especially our European crude, which sells for a U.S. $14 premium over Brent.

The blue bar in the chart is Vermilion annual realized oil price and the orange line is the annual price for the light oil in Western Canada. On average, we've received a $5 premium per barrel compared to our Canadian peers.

Moving on to European gas, which has seen a material increase this year. The chart on Slide 32 shows the price of European gas in yellow in Canadian dollar per MMBtu, Asian LNG prices in gray and AECO gas prices in orange. The blue bars represent the average realized gas price for Vermilion.

As you can see, European gas has historically traded at a $5 to $6 premium over AECO, but that premium has expanded to approximately $35 a day and remains elevated in 2023. There are many factors contributing to the premium gas prices in euro, geopolitical tension, declining domestic production, global LNG competition and increasing carbon pricing.

While the tragic events in Ukraine are one of the contributing factors, there are many other underlying fundamental drivers supporting euro gas prices. Europe consumes approximately 45 to 50 Bcf a day of gas, and we expect that demand to grow with the planned closure of coal and nuclear plants.

Natural gas is now recognized by EU as a necessary transition fuel. As a result, the use of gas in the power sector is expected to rise. Today, Russia supplies approximately 40% of Continental Europe's gas, but the EU is focused on reducing its reliance on Russia.

That leaves LNG as a critical part of Europe's gas supply. LNG is a very competitive market due to the increasing global demand and there's a limited amount of new LNG export capacity being added in the next several years. New LNG projects are very capital-intensive and will require longer-term contracts to ensure development proceeds.

Given all these factors, we expect to see increased volatility and structurally higher Eurogas prices for many years to come. In our European BOEs, we have increased dialogue with the local governments and regulators in the European countries to discuss how Vermilion can contribute to Europe's future energy security.

We are very encouraged by the more constructive conversations around energy security and in particular, the role of natural gas in the energy transition. As shown on Slide 33 using RBC's research, our exposure to premium global commodity prices means that we have benefited by having the highest operating netback among our peers.

On a pro forma basis, our forecasted 2022 operating netback is close to $90 per BOE. Vermilion has been a leader in ESG and within our industry for a long time, and we are very proud of this track record. We are consistently rated in the top quartile or top decile of the various ESG rating agencies.

In 2021, we formalized our near-term and long-term emission reduction targets, including an aspirational target of net 0 Scope 1 and Scope 2 emissions in our operations by 2050. We plan to set shorter targets as we navigate towards this aspirational target.

We are on track for our first milestone to produce our Scope 1 emission intensity by 15% to 20% by 2025. ESG is becoming an increasingly important for our sector, and we are intent on maintaining our leadership position. While the first part of my presentation focused on past results and the key attributes of Vermilion.

The next few slides will speak to what we'll do with the free cash flow we are generating. Slide 36 provides an outline of our free cash flow allocation framework and how we are thinking about it. Our focus since 2020 was on debt reduction. Our message has been very consistent over the past several months.

Once we get to our $1.2 billion debt target, we will increase our return of capital to our shareholders. As a reminder, from our peak debt levels in 2020 to year-end 2022, we are on track to reduce debt by approximately $1 billion. That $1 billion of absolute debt reduction equates to approximately $6 per share of equity value.

Debt reduction expected to be largely behind us in 2023, we are well positioned to allocate a lot more of our free cash flow to the return of capital. This may come in the form of an increase to base dividend, share buybacks, special or variable dividends.

As you can see in the chart on the right, we expect to achieve our next debt target in the second half of 2022, and we are on track to be debt-free in 2023 based on analyst estimates. Slide 37 expands on our financial leverage profile and illustrates the significant deleveraging achieved over the past 2 years.

This slide also highlights the low leverage we operate at for over a decade. Now that we are back into our targeted leverage range, we will remain disciplined and maintain a low leverage ratio. Despite all of these positive developments, we continue to trade at a significant discount relative to our peers.

As you can see in this research from National Bank on Slide 38. With our balance sheet now in a strong position, we believe this gap will be closed over time as we implement our return of capital framework and continue to follow our core business principles. While we spent a lot of time talking about Vermilion's key attributes and our upcoming return of capital framework.

As shown on Slide 39, it's important to remember that Vermilion's success has successfully executed this business model for over 2 decades and generated significant value for our shareholders. We are very excited about the strong position of the company. So a summary on Slide 40. We are trading in a very compelling valuation. We're well positioned for growing free cash flow, accelerated deleveraging and are increasing our return of capital.

Our unique portfolio of international diversified assets provide exposure to global commodity prices, which results in the top decile netbacks enhances our free cash flow. We take a disciplined approach to managing the balance sheet and returning capital to shareholders, and we recently reinstated the base dividend and plan to enhance our return of capital to shareholders once further debt targets are achieved.

Our value-driven acquisition strategy is focused on maximizing per share value as demonstrated by our recent Corrib and Leucrotta acquisitions. We are an industry leader in sustainability and ESG as evident with our high ratings from various ESG agencies, and we are intent on maintaining this leadership in the future.

In closing, I would like to thank our talented employees for their contributions that made the significant progress in the last 2 years possible. With that, we will open it up for questions.

[Kyle Preston, executive]

Thank you, Dion. We do have a few questions online here. What I will do is read them out and let you and the team respond to them. So the first question, can you provide an update on your return on capital framework and when you expect to increase it and what form of capital return you are anticipating?

[Anthony Hatcher, executive]

Thanks for that. I'm going to pass that one over to Lars Glemser to address.

[Lars Glemser, executive]

Great. Thanks, Dion. And for sure. So our return to capital framework, it does remain consistent with prior messaging, which I'll summarize here. Just a reminder, our current dividend of $0.24 a share per year represents less than 2% of our pro forma FFO at ship pricing and less than 5% at mid-cycle.

So really, there is ample room to increase this base dividend and stay within our targeted payout range of 5% to 10% of FFO at mid-cycle pricing. To address future return on capital opportunities. I think what we can do is use the approximate $11 per share of pro forma free cash flow that we are generating in 2022 to frame.

For 2022, this FCF per share has been used to execute opportunistic acquisitions. And as Dion mentioned, these acquisitions are adding 16% more production behind each share upon exiting 2022 versus our original budget. We are also reducing debt to position us to exit the year below our net debt target of $1.2 billion, which translates to 1.2x leverage at our mid-cycle price deck.

And then as mentioned, we're also -- we have reinstated a fixed dividend of $0.24 per share per year. So this really is a lot of free cash flow per share for a company trading at $24. And as we achieve that next debt target of $1.2 billion in the second half of this year, that free cash flow does not need to be as focused on debt reduction or inventory high-grading, given the progress that we've made on both fronts this year.

So just to summarize the question here, the answer to the question, the combination of low current dividend payout ratio line of sight to achieving our next debt targets and a high free cash flow yield that is in excess of 40% provides ample opportunity to increase that base dividend and allocate meaningful free cash flow to share buybacks to further strengthen the company over the long term.

[Anthony Hatcher, executive]

Thanks, Lars. And just to repeat that message. We're quite excited about the level of free cash flow in our business and achieving these debt targets and unlocking that free cash flow or a portion of that free cash flow for our shareholders. Back to you, Kyle.

[Kyle Preston, executive]

Yes. Thank you, Lars, and Dion. The next question up here is, given the recent events in Europe and the greater focus on energy security, are you seeing any positive developments from the regulators on permitting time lines and ability to expand production in the region?

[Anthony Hatcher, executive]

Thanks, Lars. I'll take this one. And I referred to it partially in the presentation here, but I would, say we're seeing a lot of constructive conversations with the governments and regulatory bodies, especially around our conversation around how we, as Vermilion could be part of that transition, in particular, provide more European gas into the mix.

Some recent examples within Netherlands, there was a motion within parliament to accelerate the small field development. And we're -- that is the framework in which we operate these cash flows in Netherlands and Germany, lower [indiscernible], government has shown a new willingness to work with the industry to bring more production on.

So what we're doing within our shop, we've actually added some resources to be able to get more permits in the system. And we're happy to work within the framework that's there. And again, encouraged by the discussions and the willingness and the need to have more certainty around the security of supply within Europe.

[Kyle Preston, executive]

Thank you, Dion. Next question online here. Can you provide an update on your Croatia gas project, including timing of first production expected realized pricing, future drilling plans and ultimate production potential?

[Anthony Hatcher, executive]

Thanks, I'm going to pass that one over to Darcy, our VP of International.

[Darcy Kerwin, executive]

Thanks, Dion. So we anticipate that the SA-10 gas plant in Croatia will come on stream mid-2023. So as -- kind of as part of our conservative value-driven approach, we purchased this existing plant in the Netherlands and then moved it to Croatia.

So the plant has a nameplate capacity of approximately 6 million cubic feet per day or approximately 2,500 BOED. And we could increase that capacity as necessary by debottlenecking that plant. In our 2022 drilling program, we intend to drill 2 additional wells on the SA-10 block. And any gas discoveries that we make would be tied into this gas plant with the intent really to keep the plant 100% full at plateau rates.

We have also recently completed a 3D seismic program on our SA-7 block in Croatia, and our geoscience team is working to interpret the process data. We're pretty excited about the production potential on both of these blocks in Croatia, and we would expect that any gas production in Croatia would be exposed to the full TTF gas price. So it would be a full TTF price minus approximately EUR 1 per megawatt hour for transportation.

[Anthony Hatcher, executive]

Thanks, Darcy. Yes, it's fair to say we're excited about 2023 and getting these wells that have been tested it 18-plus million a day on production. But with that, back to you, Kyle.

[Kyle Preston, executive]

Sure. We have one more question online here. Is Vermilion looking at other international acquisition opportunities? And if so, where?

[Anthony Hatcher, executive]

I'll take this one, Kyle. We obviously have our core operating regions in Europe, we touched on in the presentation. What we're excited about is we've got a strong, long track record, 25 years required from the majors jurisdictions and doing that at a very attractive rate of returns.

As we look to the future, we see opportunities as the majors have announced their plans to divest in these areas. In particular, there's been announcements in Germany and Netherlands. So at this point, we kind of look at everything, we screen everything, but we don't bid on everything, but we do see a lot of opportunities in the future in the jurisdictions that we operate.

So I think what the investors should expect is for us to continue to focus on the areas in which we are given the number of opportunities we see on the horizon. I think that's the best way and part of our consolidation strategy what we referred to in the presentation.

[Kyle Preston, executive]

All right. Thanks, Dion. There are no further questions.

[Anthony Hatcher, executive]

Well, with that, I want to thank you again for participating in our conference call, and we'll adjourn the meeting.

[Kyle Preston, executive]

Thank you. That does conclude today's conference. We thank you all for your participation. You may now disconnect.